How Imports INCREASE GDP

By Thomas Firey

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In recent posts, Pierre Lemieux and Scott Sumner refuted a common but mistaken idea: that because gross domestic product can be calculated by taking national expenditure data (i.e., the “C + I + G” part of the equation) and adding the value of exports while subtracting the value of imports (the “X – M” in said equation), imports reduce GDP.

This mistake should be obvious to people who have weighed themselves at the gym and then subtracted a few pounds to allow for the weight of their shoes and clothes: wearing heavier clothes doesn’t change their bodyweight. Similarly, subtracting imports that were included in C, I, or G expenditures does not reduce the “weight” of GDP. Still, this mistake is so common that such folks as Trump administration trade adviser Peter Navarro (a Harvard economics PhD, no less), political figure Pat Buchanan, countless economics reporters, and others who should know better routinely make it.

One of the reasons this error persists is that it echoes another mistaken but intuitively compelling idea: the imported goods could have been made domestically, and thus would have added to domestic employment. To show that this intuition is false, economists recite the theory of comparative advantage. Unfortunately, trying to explain what has been called the most counterintuitive idea in social science is not a winning debate strategy.

So here’s a different strategy: tell the story of the cocoa bean, one of many U.S. imports that increases American GDP and employment.

Cacao trees, which produce the bean, grow only in hot and humid conditions. Most of the world’s cacao comes from right along the equator; practically none comes from the United States. (American Samoa produces something like 0.0002% of the world’s crop). Yet the United States is one of the world’s largest chocolate producers, using cocoa beans imported from Ivory Coast, Ghana, Indonesia, Trinidad, and elsewhere.

I live just a few miles from Hershey, Pennsylvania, where enormous quantities of cocoa are processed daily by thousands of workers into Hershey bars, Reese’s Cups, Kisses, and other confections. Those jobs would not exist if not for the imported beans. Likewise, countless dairy farmers (including generations of my family), peanut farmers, sugar producers, and truckers depend on Hershey for work. Also, countless domestic dairies, bakeries, restaurants, cereal makers, and snack food makers use Hershey chocolate products in their wares.

The same is true for U.S. chocolate factories operated by Mars, Ghirardelli, Ferrara, and others. Most if not all of that production—and the tens of thousands of jobs behind it—would disappear without imported cocoa beans (though perhaps some would continue by using artificial or alternative flavors). That’s how this imported bean creates American domestic production and jobs, completely contrary to the explanations of Navarro, Buchanan, et al.

They would likely respond to this anecdote by saying that the destroyed jobs would be replaced by other jobs elsewhere in the economy. This is true, but the affected workers could move to those jobs now if they wanted to. Instead, they stick with chocolate-making because they are more productive and better paid. That is the point of the theory of comparative advantage: you produce what you can do more efficiently (like chocolate in Pennsylvania) and you import what others in the world can produce cheaper (cocoa beans).

This effect is not isolated to one temperamental tree. Cheap imported steel, aluminum, softwood lumber, and other inputs do the same thing. Even when domestic supplies of those inputs are available, the preferred foreign supplies result in higher employment and greater economic output in the United States by supplying a better intermediate good. It also works for finished goods; by importing, say, washing machines and solar panels, Americans free up more of their income to employ building contractors, dentists, artisanal bakers and vintners, musicians, mechanics, etc.

At a time when U.S. employment is below 4 percent and American wages are finally beginning to climb, it’s baffling that U.S. politicians want to put a number of productive jobs at risk because of a woeful misunderstanding of trade and economics.

As the old commercial said, Hershey is the Great American Chocolate Bar, yet it wouldn’t exist without imports. The same is true for plenty of other American goods.

READER COMMENTS

Steve Fritzinger

Sep 11 2018 at 7:30pm

If Navarro was right we could boost GDP by $140B/yr by not importing oil.

Scott Sumner

Sep 12 2018 at 2:48am

Thomas, Very good post.

Steve, Good example.

Benjamin Cole

Sep 12 2018 at 3:36am

Is it a bit glib at this late stage to fall back on an agricultural import to make a point about free trade.

I understand comparative advantage, and Ricardo (who pondered heavily agricultural economies). Yes, mutton and wine, and wages adjust (although Ricardo regarded capital as bound by borders). The Ricardian model is another way of saying, “let the price signal allocate resources.”

I like the price signal!

But in the modern world, there are huge institutional imperfections. Some nations, such as Singapore and China, provide free land and capital for industry, especially export industry. Indeed, a national policy of Singapore is to pursue current-account surpluses (btw, per capita GDP PPP in Singapore is 50% higher than the US).

In the case of China and Singapore products, the price signal becomes bogus. The price signal may not allocate resources to the most efficient producers, but only to the most subsidized.

Thus, a global “free trade” model, without tariffs, may only reward those industries that are most subsidized, and can predictably result in the misallocation of resources. This elementary point should be included in any “free trade” conversation.

There are other concerns. The IMF recently posited large trade current-account trade deficits in the US are leading to asset bubbles, and they predict “financial instability” and maybe worse. All that capital pouring in has to find a home.

PS. Surely, there are locational advantages to producing cacao beans. But what about cars? They seem to be commercially produced in Germany, South Carolina, Tennessee or Korea, Japan, China and Thailand (haha, everywhere except Detroit).

Foxconn says it will spend $10 billion on a HD TV screen plant in Wisconsin. Why? There are comparative advantages in Wisconsin? No, there is free land and free government services and no taxes. Wisconsin did a Singapore-lite. This is how industry is located in the modern world.

In the end, there is no such thing as “free,” “fair” or “foul” trade. The ideas are meaningless in a world where many nations regarded commerce as a marriage between enterprise and state.

Is that “free” trade? You might as well bring an umpire to an NFL game. Played in the dark.

Unless you think it is “free trade” when nations subsidize exports, for reasons deeply endemic to their cultures and political and economic philosophies.

Philo

Sep 12 2018 at 12:54pm

In the modern world there are institutional imperfections? When have there not been institutional imperfections? Do you think Ricardo was unaware of institional imperfections?

Yes, there can be free trade even if governments subsidize certain industries, just as there can be free trade even if a billionaire subsidizes his trophy wife’s fashion design business.

Hazel Meade

Sep 12 2018 at 3:11pm

Why should Americans object to China subsidizing industries that export to the US? Yes, it makes Chinese products more competitive against US products, but it also makes Chinese products cheaper for US consumers.

This goes back to the notion that the goal of any economic policy should be to provide jobs. That is incorrect. Jobs exist so that people can buy things and consume. Why do work that you don’t need to? The harm here is not to Americans but to Chinese taxpayers who are subsidizing products that Americans consume. Some American workers are harmed, yes, but more importantly the people who are really harmed are the stockholders and owners of the competing companies – the people making profits off of selling American manufactured products to American consumers lose money due to foreign competition from subsidized industries. But American consumers more broadly benefit – Chinese taxpayers are giving them a discount! We shouldn’t confuse the interests of American corporations with the interests of Americans.

dede

Sep 12 2018 at 9:59pm

“No, there is free land and free government services and no taxes. ”

So, here you go : if you believe that Singaporean companies are competitive thanks to free land (which I would doubt when I look at the scarcity of land down there), please implement the same policy.

“Fighting back” with tariffs is absurd : Singapore does not impose any tariffs (apart from a small one on beer : the draft TPP was kind of hilarious on that), copy that as well.

David Krstopeit

Sep 13 2018 at 10:05am

Mr Cole,

I live in Racine, WI where the Foxconn project will be built. There was no “Free” land. There is no “Free government services” nor does Foxconn get immunity from taxation. In fact they will have a heavy tax burden most of which will initially go to pay off the bonding done through creation of Tax Incremental Financing districts. Once that bonding is paid off any future taxes go to the general fund. On top of this, the 13,000 workers that Foxconn will hire will be paying millions of dollars in taxes to their local communities and to the state of Wisconsin. If they do not hire 13,000 workers, the Foxconn agreement with the state eliminates certain tax credits they were to receive.

For the last 10 or 15 years Racine has had one of the highest unemployment rates in Wisconsin. What does that cost the state and local governments? Racine has also had some of the lowest real estate values in Wisconsin. Now real estate values are soaring. This project is a win win for everyone – both taxpayers and government entities.

Racine was at one time a hotbed of entrepreneurship and manufacturing with companies such as SC Johnson Wax, J I Case, Hamilton Beach, In Sink Erater, Horlick, Masssey Ferguson, and dozens of others all calling Racine home. Many have downsized or moved out. Consequently the city population has gone from a high of 95,000 to the current 73,000. What has that cost our community in lost tax dollars?

Foxconn is a savior. Our Governor and local governments should be congratulated on coming up with a plan to make this happen.

Jorge Morales Meoqui

Sep 15 2018 at 6:56am

Dear Benjamin,

The theory of comparative advantage, as is commonly understood, contradicts in several ways what David Ricardo actually wrote in the Principles. I have highlighted elsewhere these differences but won’t go into specifics here. In resume, one can say that there is very little Ricardo, if anything at all, in the “Ricardian” trade model of economics textbooks.

Moreover, Ricardo was very much aware of the price signal as this quote proves: “The motive which determines us to import a commodity, is the discovery of its relative cheapness abroad: it is the comparison of its price abroad with its price at home.” That was his (and Smith’s) rule for international specialisation.

Todd Kreider

Sep 12 2018 at 8:44am

Sep 12 2018 at 9:09am

Via trade, it does. Jobs are created in more productive sectors and destroyed in less productive sectors, which is what creates GDP growth.

Todd Kreider

Sep 12 2018 at 9:20am

The jobs part is irrelevant. What if Hersey was 95% automated and that the import of cocoa produced almost no new jobs?

Hazel Meade

Sep 12 2018 at 3:44pm

You are correct. People always think that jobs are a measure of prosperity. They’re not. Consumption capacity is. If Hershey was 95% automated, the price of their chocolate bars would plummet. We would either end up with lots more ability to consume chocolate, or (more likely) Hershey would start producing more high end chocolate and the quality would go way up.

Sep 12 2018 at 3:58pm

If Hershey couldn’t import, those jobs that make up the 5% wouldn’t exist.

Todd Kreider

Sep 12 2018 at 4:21pm

But others would. Hersey will inevitably become much more automated and those current jobs would leave, making the company more productive. Job increases don’t add to GDP just as job losses do not subtract from GDP.

Sep 13 2018 at 8:30am

However, using the EWOT, the jobs that would exist absent Hershey’s importations would be less productive. GDP would be lower than it otherwise would be.

Todd Kreider

Sep 13 2018 at 2:38pm

However, using the EWOT, the jobs that would exist absent Hershey’s importations would be less productive. GDP would be lower than it otherwise would be.

But the difference is often so small that is negligible.

Sorry to repeat myself but to use a recent example, there is a new pizza delivery service in San Francisco that plans on using driverless cars and has eliminated many traditional pizza parlor jobs through heavy automation. Let’s say the CEO automates everything living him as the sole worker. The increase in GDP is due to the consumption of his roboticly made and delivered pizzas and GDP would not go down as former employees are fired.

Todd Kreider

Sep 13 2018 at 3:03pm

Oh, and the machines along with the driverless cars are all imported.

Hazel Meade

Sep 12 2018 at 10:17am

I have found it quite effective to emphasize that imports are used to make things for export. Especially raw materials like steel and aluminum. People respond to the idea that we want American workers to be higher in the value chain, making more finished products, and we want those finished products to be globally competitive – so it makes sense to purchase cheap raw materials from outside and then produce a competitive finished product in the US. Once you get people to see that, you can expand on that to more complex supply chains. You can get around some of the counter-intuitive nature of comparative advantage by directing their intuition that exports are good towards the effect on exports of not using the most cost-effective (i.e. imported) inputs.

Sep 12 2018 at 3:59pm

I have found it quite effective to emphasize that imports are used to make things for export. Especially raw materials like steel and aluminum.

The problem with this is it gets the logic of trade backward (not that you do this, but it accidentally reinforces the illogical goal that one consumes so he can work harder as opposed to working so he can consume)

Mark Brady

Sep 12 2018 at 6:07pm

Exponents of free trade are apt to rely on the application of the concept of comparative advantage to the exclusion of the concept of increasing returns. Yet the concept of increasing returns surely goes a long way to explain specialization in manufacturing (and services) in the modern world. We’re talking about footloose industries where often the initial specialization is explained more by historical accident rather than by intrinsic differences in comparative advantage arising from variation in climate and soil. Of course, this doesn’t mean that the theory of comparative advantage is mistaken but it does reduce the usefulness of the concept to explain international trade.

Sep 12 2018 at 9:56pm

Comparative advantage doesn’t depend on soil or climate or anything like that. It depends on opportunity cost

Jorge Morales Meoqui

Sep 15 2018 at 2:24pm

Dear Jon,

You are referring to the notion of comparative advantage promoted by the Austrian economist Gottfried von Haberler.

For Ricardo, however, soil, climate and other natural advantages played, of course, a crucial role in determining the location where some commodities should be produced. He stated in the Principles:

It is quite as important to the happiness of mankind, that our enjoyments should be increased by the better distribution of labour, by each country producing those commodities for which by its situation, its climate, and its other natural and artificial advantages, it is adapted, and by their exchanging them for the commodities of other countries, as that they should be augmented by a raise in the rate of profits (Vol. 1, p. 132).

Sep 15 2018 at 3:08pm

Jorge-

I didn’t say comparative advantage doesn’t factor in climate and things like that. I objected to the fact that it depends on elements like climate. It does not. A country may have absolute advantage in many things because of its climate, but not comparative advantage in those same things. It’s not impossible to imagine situations where opportunity costs swamp gains from climate.

Jorge Morales Meoqui

Sep 15 2018 at 3:54pm

Dear Jon,

Thanks for the clarification. The contraposition of absolute and comparative advantage in the cost of production was introduced by John Stuart Mill, and it ended up confusing everybody. It is based on the erroneous inference that the cost of production of the English cloth was higher than that of the Portuguese cloth because the former required more quantity of labour in Ricardo’s famous numerical example. It has been proven here that the English cloth had a lower money cost of production than the Portuguese cloth.

Thus, I prefer to stick to what Smith and Ricardo actually wrote, which is intuitive and way simpler to understand. Commodities of similar quality are imported when the price is lower than the price of the local production. The cost of production of specific agricultural products will be lower where natural conditions are favourable.

Jorge Morales Meoqui

Sep 14 2018 at 11:33am

Dear Mark,

I have written a paper which proves that the theory of comparative advantage, as it is commonly presented in economics textbooks, is mistaken. It is based on a misinterpretation of David Ricardo’s famous numerical example in the Principles.

Here is a link to the paper, in case you are interested in reading it.

Jorge Morales Meoqui

Sep 15 2018 at 8:24am

Ahmed Fares

Sep 12 2018 at 6:19pm

“a rise of one percentage point in the ratio of trade to G.D.P. increases income per person by at least one-half percent.” —economists Jeffrey A. Frankel of Harvard and David C. Romer of the University of California, Berkeley

There, we’ve proven empirically that trade, which implies imports, increases GDP, just as Ricardo said it would.

Imports increase GDP. In an economy operating at full capacity, yes. But what happens in an economy not operating at full capacity.

Say you’re buying all those imports but your trading partners are buying your government bonds instead. Now Don Boudreaux argues that the bond sellers can only do one of two things with the proceeds of those bond sales, consume or invest, both of which create jobs.

But what if the bond sellers simply park the cash instead. What happens to local employment then?

If your export sector is not exporting, then it is not earning which means it is not spending. In that case, GDP would fall.

So I would argue that imports increase GDP in good times, but they decrease GDP in bad times.

Sep 12 2018 at 9:57pm

That doesn’t make sense. Why would they do that? They’re taking out a loan, at interest, to sit on the cash, which doesn’t earn interest.

If they want to just give money away, I’ll send them my mailing address and they can cut me checks.

Ahmed Fares

Sep 12 2018 at 11:46pm

Jon,

Sorry if I wasn’t clear. I was referring to the secondary market.

If the Chinese central bank buys a US Treasury in the secondary market, the seller is now holding cash. If the seller of that Treasury consumes or invests, that adds jobs. But if they just hold a money balance, that does not translate into jobs.

That third option, of just holding the cash, is never mentioned. It’s as if a capital account surplus always generates jobs in investment. I’m arguing that it doesn’t.

Sep 13 2018 at 2:57am

Ahmed,

You’re suggesting that there is a significant amount of Treasury sellers who are taking the proceeds and putting it into cash physically stored away somewhere, like a mattress or a safety-deposit box? I find it difficult to believe much of that goes on.

Instead, I imagine even if someone has a preference for cash, at the level of sales to make it significant, they’re much more likely to keep that cash on deposit at some institution, like a bank. In turn, that institution is going to invest it (see also fractional reserve banking) in the form of a loan, etc… so you still have large cash balances increasing investment in the end.

Ahmed Fares

Sep 13 2018 at 2:39pm

Thomas,

Fractional reserve banking is a myth. Loans create deposits, not the other way around. As for how bank lending works:

“As many of you know, I have spent much of the last seven years explaining to anyone who will listen that banks do not “lend out” deposits or reserves. Rather, they create both loan assets and matching deposit liabilities “from nothing” by means of double entry accounting entries. Creating money with a stroke of the pen (or a few taps on a computer keyboard) is what banks do.” —Frances Coppola

Investment is not funded by saving. Investment is funded by credit creation. Investment brings forth its own saving.

Contrary to the loanable funds theory, finance in the world of Keynes and Minsky precedes investment and saving. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.

S = I does not mean that saving translates into investment. It means that investment translates into saving. The causality is in the other direction.

Sep 13 2018 at 8:29am

My question remains: why would someone sell an interest-earning asset to hold an asset that does not earn interest?

Ahmed Fares

Sep 13 2018 at 3:10pm

Jon,

Investors desire to hold cash balances in recessionary times. Fear of job loss enters into that. Return of capital becomes more important than return on capital.

As regard interest rates, I don’t believe in time preference theory. I hew to the idea of Keynes’ liquidity preference theory below (my comments are in italics):
The transactions motive states that individuals have a preference for liquidity in order to guarantee having sufficient cash on hand for basic day-to-day needs. In other words, people have a high demand for liquidity to cover their short-term obligations, such as buying groceries, and paying rent or the mortgage. Higher costs of living mean a higher demand for cash/liquidity to meet those day-to-day needs.
The precautionary motive relates to individuals’ preference for additional liquidity in the event that an unexpected problem or cost arises that requires a substantial outlay of cash. These include unforeseen costs like house or car repairs. (job loss would go here)
Individuals may also have a speculative motive. When interest rates are low, demand for cash is high as individuals prefer to use the cash or hold onto it until interest rates rise. The speculative motive refers to investors’ general reluctance to commit to tying up investment capital in the present for fear of missing out on a better opportunity in the future. When higher interest rates are offered, investors will give up liquidity in exchange for the higher interest rates. As an example, if interest rates are rising and bond prices are falling, an investor may sell their low paying bonds and buy higher paying bonds, or hold onto the cash and wait for an even better rate of return. (desire to hold cash balance to be able to take advantage of investment opportunities, like during a recession when weak hands are selling).

Sep 15 2018 at 3:10pm

You’ve still not answered the question: why would someone dump an asset that earns interest for one that does not? There is a reason, but you need to give it.

I need a theory from you to support your claim

Ahmed Fares

Sep 16 2018 at 1:57am

Jon,

“why would someone dump an asset that earns interest for one that does not?”

Let me try again.

Assets don’t just earn returns, they entail risk. The whole risk/reward trade-off. In turbulent times, investors become risk averse. They then seek to trade away returns for liquidity.

As an example, say you are holding a 5-year corporate bond. Bonds have a default risk. If the economic outlook looks good, people are content to hold the bond because the default risk is low. But if the economic outlook worsens, then default risk rises. The desire to hold bonds falls. Cash is more desirable than a falling asset.

Because for every seller there has to be a buyer, investors in the aggregate can not increase their money balances. Someone has to hold the assets. One of the reasons for QE was for the central bank to hold the assets, government bonds and mortgage-backed securities, to enable the private sector to increase its money balances, and by extension lower interest rates.

The attempt to shed assets leads to falling asset prices. Falling asset prices means higher interest rates (bond yields rise as bond prices fall). This in effect, acts as a restrictive monetary policy, the last thing you want in a recession. Which is why the Fed buying bonds to hold the price up, and by extension the yields down, was one of many reasons for QE.

As an aside, I like the following quote from Warren Buffett:

“Cash is generally regarded as a drag on investment returns, but sometimes it may be preferable to hold a substantial cash amount instead of investing it in other assets. This is because having cash on hand gives an investor the flexibility to acquire an asset or assets at bargain prices when the opportunity arises. In this respect, cash can be viewed as a call option – on virtually any asset – with no expiration date.”

Buffett here uses the word “flexibility” which is synonymous with “liquidity”.

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